8) A stock has a beta of 1.75, the expected return on the market is 8%, and the

ID: 2622462 • Letter: 8

Question

8) A stock has a beta of 1.75, the expected return on the market is 8%, and the risk-free rate is

1.5%. What is the expected return on the stock?

9) You have $250,000 to invest in a stock portfolio containing Stock H and Stock W. Stock H

has an expected return of 15 percent and Stock W has an expected return of 4.5 percent. If you

wanted a portfolio with an expected return of 12 percent, how much money will you invest in

Stock H?

10) If a stock has a beta of 1.25 and the standard deviation of the market is 35%, what is the

covariance between the stock and the market?

The answer goes as follows:

8)As per CAPM model:

Required rate of return=Risk free rate+(market Rate-Risk free rate)*Beta

=1.5+(8-1.5)*1.75

=12.875%

9)Expected return shall be a combination of 2 stocks such that the Investor earns a return of 12% from the Portfolio

Hence expected return shall be=Weight of H*Return on H+Weight of W*Return on W

Or 12%=Wh*0.15+(1-Wh)*0.045

Or 0.12=0.15Wh-0.045Wh+0.045

Or 0.075=0.105Wh

OR weight of H shall be=0.71

Hence money invested shall be=0.71*250000

=$177500.

10) now we know that :

Beta=Covariance/variance

And Variance is (S.D)^2

Hence Covariance=1.25*0.35*0.35

=0.153

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